Hedge Funds Rail on Markets, Regulators

The third quarter is off to a vocal start for some of the world’s top hedge-fund managers, who are weighing in on everything from “stumbling” European governmentsto “dumb” internal bank trades and “Kafkaesque” domestic financial regulations.

But perhaps more remarkable is his assessment of global markets, which he says have been rendered dysfunctional by a combination of “inchoate” financial regulation, consequently frightened banks and consumers, and government “brinksmanship.”

“I shudder to think of the stress that is going to occur during the next credit liquidation cycle — as bad as it has historically been in down markets, at least the banks would have made a market, however wide, and taken an inventory,” Bacon writes. In today’s environment, however, there’s little chance of market-making, he suggests.

And when it comes to the Fed actions that are hotly anticipated on days like Wednesday? Like “junkies,” he writes, markets “now demand more frequent monetary hits in greater size.”

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It’s hard to say which Bacon thinks is worse — wrongheaded lawmaking in the U.S., which has spooked financial players, or shortsighted regulators in Europe.

“The Euro zone remains a potential disaster area of catastrophic proportions,” Bacon writes, “with governments stumbling from one summit to the next.” Traders, he says, are now used to “Euro zone summits where the de facto best outcome is action that cuts off imminent tail risk, provoking a brief short-covering rally that belies a concrete and important resolution.”

That European regulators haven’t hastened further bank capital-raising is “astounding,” he adds, “given that the European banks’ business models run on higher leverage and more flighty short-term, wholesale funding.” Earlier Wednesday, Third Point Management founder Daniel Loeb made his own critique of Europe in an investment letter, describing it as a place of “continental chaos.”

Bacon’s most scornful line, however, pertains to the financial regulatory overhaul known as the Dodd-Frank Act. He calls the legislation, whose details are still being interpreted, “inchoate.” He adds that naming the reforms after Sen. Chris Dodd and Rep. Barney Frank — a pair of lawmakers he calls “the two high protectors from regulatory oversight of perhaps the most egregious of U.S. financial miscreants, Fannie Mae and Freddie Mac” — is a “Kafkaesque absurdity.” Loeb also couldn’t resist a dig at domestic politics, arguing that “the Obama Administration…is openly hostile to most businesses and unable to articulate or implement policies to spark growth and reduce unemployment.”

The Moore and Third Point missives came a day after a strongly-worded second-quarter letter from BlueMountain Capital, whose chief, Andrew Feldstein, took the occasion to rail on the muted reaction to the recent LIBOR scandaland the press fascination with what he regards as more trifling matters, like JP Morgan’s misguided corporate-credit derivatives trades — on which he appears to have made tens, if not hundreds, of millions of dollars.

“As in the classic children’s tale, there is a danger to crying ‘wolf’ when no moral risk exists,” Feldstein wrote. “We become so inured to the parade of over-hyped misdeeds that we fail to react appropriately when the real wolf appears.” In short, he added, “LIBOR is orders of magnitude more significant than some dumb trades that halved the quarterly profits of an otherwise robust bank” — his former employer and in this case, counterparty, JP Morgan.

Feldstein also lent his view on former Citigroup CEO Sandy Weill’s call for a reinstatement of the Glass-Steagall Act, which would force huge banks like Citi and JP Morgan to break themselves up into separate commercial and investment-banking units.

“To counter systemic risk and satisfy our sense of fairness, we need stronger bulwarks against contagion and the permanent end to any notion of ‘too big to fail,’” Feldstein wrote. “But replacing private business judgment with the judgment of politicians, regulators, or the press promises only worse results.”